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Monday, February 15, 2010

More on the Eurozone Challenges

Ambrose Evans-Pritchard reports on the latest challenge in the Greek bailout:

The EU has issued a political pledge to rescue Greece – and by precedent, all Club Med – without first securing a mandate from the parliaments of creditor nations.

Holland's Tweede Kamer has passed a motion backed by all parties prohibiting the use of Dutch taxpayer money to bail out Greece, either through bilateral aid or EU bodies. "Not one cent for Greece," was the headline in Trouw. The right-wing PVV proposed "chucking Greece out of EU altogether".

Germany's Bundestag has drafted an opinion deeming aid to Greece illegal. State bodies may not purchase the debt of another state, in whatever guise.The EU is entering turbulent waters by defying these irascible and sovereign bodies...

This is why a common treasury is essential to any currency union. Imagine Texas refusing to allow its tax revenues to flow to the union-laced Michigan economy. Or the state of New York not allowing its taxes to support the bigoted folks in certain parts of the country. The dollar currency union would be in trouble too. Fortunately, there is a federal treasury. In Europe they are not so fortunate. Here is Evans-Pritchard:

The last two weeks have cruelly exposed the Original Sin of monetary union: that EMU was launched without an EU treasury or debt union. This will be tested again and again by bond vigilantes until such a mechanism is created.

I have my doubts about a EU Treasury being created. It is possible, though, that this crisis could be the catalyst that makes it happen. Finally, here he is explaining why the Eurozone is not an optimal currency area:

Europe's leaders still refuse to face the awful truth: that monetary union is unworkable as constructed. That different labour markets, different sensitivities to interest rates, different economic structures, have caused the gap between North and South to grow ever wider...

3 comments:

Perhaps I am wrong, but the U.S. dollar currency union survived a variety of state government defaults.

When the Democrats would win the election in a state and say, hell no we aren't paying off those Whig bonds used to build roads and dams and line the pockets of Whig political supporters--the result was that investors in those bonds took a loss.

Why not just have the European Central bank maintain European nominal expenditure. No doubt things will be tough in Greece. And perhaps it would have been better for Greece if the result of the crisis is that import prices go up.

But I don't quite understand the what the problem would be for the rest of Europe.

Personally, I think the U.S. should just let the government of Michigan default and the Fed should maintain nominal expenditure in the U.S.

Okay, given that labor markets and wages/prices are more flexible in the U.S the fiscal transfer criteria (i.e. common treasury) is probably less binding here. Still, it would be hard to imagine the Fed doing what it does today if, say, the Articles of Confedaration were still the U.S. constitution.

I think issue with just maintaining nominal expenditure growth in EU is that ECB would aim for the Eurzone average (as it does now when it sets interest rate targets) which may mean certain regions have too slow of growth in nominal spending while others are too fast. Given the lack of labor mobility, rigid prices, and the absence of fiscal transfers there wouldn't be sufficient buffers against the inappropriate nominal spending growth in the affected regions.